How bad are bad assets of banks?

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gsr-001245State-run United Bank of India on Friday reported a Rs.1,238.08 crore net loss in the December quarter after setting aside Rs.1,857.83 crore to provide for bad loans. Following the hefty provision, its net non-performing assets (NPAs) were pegged at 7.52% of total advances. The Kolkata-based bank’s gross NPAs are much higher at 10.82%—reminiscent of the banking industry’s health in the late-1990s when high interest rates and tight liquidity led to large-scale defaults by corporations and banks’ bad assets and restructured loans zoomed.

While United Bank’s gross bad assets are in the double digits, there are six other state-run banks that have more than 5% gross NPAs—State Bank of Mysore (6.56%), Central Bank of India (6.48%), Andhra Bank (5.55%),Allahabad Bank (5.47%), IDBI Bank Ltd (5.44%) and Indian Overseas Bank(5.27%). State Bank of India, the nation’s largest lender, is yet to announce its December-quarter earnings. In the September quarter, its gross NPAs were 5.64%. Punjab National Bank had 5.14% gross NPAs in the September quarter but managed to bring it down to 4.96% in the three months ended 31 December.

After setting aside hefty sums of money that dented profits, at least five Indian banks now have more than 3% net NPAs.

Let’s take a closer look at the universe of Bankex, 12 of the 41 listed banks that constitute BSE Ltd’s banking index. Since State Bank of India has not yet announced its earnings, we can look at the health of 11 banks. Collectively, their net NPAs have more than doubled in past eight quarters—between March 2012 and December 2013—from Rs.16,275 crore toRs.34,792 crore. Among these banks, Bank of Baroda is the worst affected. Its net NPAs have grown from Rs.1,544 crore to Rs.6,634 crore in past eight quarters. The gross NPAs of this set of bank have not doubled during this period but risen substantially, from Rs.38,737 crore to Rs.66,142 crore. Here too, Bank of Baroda has put up the poorest show. Its gross NPAs have grown from Rs.4,465 crore to Rs.11,936 crore.

During this period, operating profits of these 11 banks collectively have risen from Rs.17,785 crore to Rs.21,779 crore. Despite that their net profits virtually remained flat—Rs.10,386 crore in March 2012 and Rs.10,593 crore in December. The reason behind this is about 50% growth in provisions. In March 2012, these banks had set aside Rs.4,149 crore to take care of bad assets. This amount has risen to Rs.6,310 crore in December 2013. In other words, had these banks not been saddled with bad assets and not required to set aside money, their profits would have risen. The state of affairs in banks outside Bankex is far worse.

One worrying factor about the health of Indian banks is that the private banks, which have till now managed to remain insulated from the phenomenon of bad assets, are showing cracks. This is not a happy sign. Gross NPAs of five of the 11 banks in Bankex have risen in the December quarter over the preceding three months and four of them are private banks. Similarly, net NPAs of seven banks in this pack have risen in the December quarter and five of them are private banks. For instance, net NPAs of Kotak Mahindra Bank Ltd has risen from 0.96% to 1.10%. The list includes ICICI Bank Ltd (from 0.85% to 0.94%); IndusInd Bank Ltd (from 0.22% to 0.31%); Axis Bank Ltd (from 0.37% to 0.42%); and Yes Bank Ltd(from 0.04% to 0.08%).

Indeed, the quantum of growth is not high—a few basis points for many of them—but could signify the beginning of a spillover of bad assets from public sector banks to their counterparts in the private sector. This is bound to happen if the Indian economy takes longer to get back its growth momentum. If the slowdown persists for longer, borrowers’ ability to pay back loans will be severely affected and both public and private banks will suffer. Higher bad loans affect banks’ profitability as they need to set aside more money to take care of such loans. As a result of this, they would also need more capital as otherwise they will not be able to grow their loan book. Taxpayers’ money is used to recapitalize public sector banks almost every year but since that is not possible for private banks, if they get affected by a rise in bad loans in their books, it might turn out to be a threat to systematic stability. A stable government at the centre after 2014 general elections, faster project clearances and growth impulse coming back in Asia’s third largest economy are key to financial sector stability in India.

On its part, the Reserve Bank of India (RBI) has taken the first step to protect the banking system by allowing banks to use up to one-third of the amount they have set aside as the so-called counter-cyclical buffers to make provisions for bad loans. Banks are being allowed to use such reserves to make specific provisions for NPAs, as per the policy approved by their board of directors. This is the first instance of the central bank allowing commercial banks to use emergency provisions since they started creating the reserves in 2010. Creation of such a reserve was under discussion since 2006 when Y.V. Reddy was the RBI governor.

RBI has also come out with a framework for a corrective action plan that will offer incentives to banks for early identification of stressed assets, timely revamp of unviable accounts and fast steps for recovery or sale of assets when a loan faces the risk of turning bad.

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